Most construction contractors have been exposed to the topic of asset protection at some point during the existence of the companies they own. For many of you, you were probably advised to organize and form your company as a limited liability company (LLC) or corporation when you started your business. These types of company structures have the advantage of shielding the owners of the company from most of the liability claims that are made against a construction company. For that reason alone, the use of LLC’s or corporations is very important as a business structure.
The role of proper business structure as a tax reduction tool is often overlooked, however. Taxes paid by a contracting business and its owners are directly tied to the type of structure used by the business during its day to day operation.
Basically, most every construction company is either taxed as a non-corporate or corporate entity. Non-corporate entities are either taxed as a sole proprietorship (if only one owner) or a partnership (more than one owner). Corporations are either taxed as an S Corporation (the owners include the income on their individual returns) or as a C Corporation (the company pays its own income taxes). Why no mention of an LLC in these tax structures? LLC entities have no tax law written specifically for their type of structure. In fact, an LLC can choose which type of tax structure it wants – corporate or non-corporate. For every business, there is a most appropriate type of structure to minimize income taxes.
Before 2018, the analysis of this was pretty simple. A specific business needed to be treated as a sole proprietorship, a partnership, an S Corporation or a C Corporation depending on a few questions:
- How much money does the business make?
- What is the structure of the ownership?
- Are the majority of the profits used personally by the owners or reinvested into the company?
- What is the long-term plan for resolution of the business?
While not a comprehensive list, these are the main factors that made one type of business entity the correct tax model over and above the others. The difference in an effective type of business entity and a poorly designed structure could be thousands of tax dollars per year.
When the tax law changes of The Tax Cuts and Jobs Act were enacted effective January 1, 2018, the planning model of previous years was suddenly out of date. The various tax benefits assigned to different types of entity structures under these new rules resulted in different answers to the type of entity questions than had been true in the past. For our clients, we reviewed the majority of the businesses that we work with under the new structure. Some of them changed the type of entity they were using to achieve substantial reductions in taxes paid. Others were structured properly but revised the compensation plans for the owners of the business. Again, the result was tax reduction – for each year to come.
If you haven’t reviewed the entity structure you are currently using in the last two years, you may be overpaying your taxes. A comprehensive review of your circumstances may yield substantial tax savings from minimal structure changes.